There is still no sign of tariff-driven inflation

We get almost no news today that would drive FX. That leaves plenty of time to contemplate tomorrow’s inflation. It’s likely to be very favorable, meaning not bad at all. We are still waiting for the tariff effect to show up. So far it’s MIA.

The NY Fed survey of consumer expectations of inflation is a shocker: one year ahead median forecast—inflation down 0.4% to 3.2%. Three years ahead, also down by 0.2% to 3.0% and five years, down 0.1% to 2.6%. They also see the employment situation their own financial conditions roughly the same. This is nuts. Who is out of touch, the average Joe or the economist herd that expects inflation and the slowing growth that is bad for jobs?

Meanwhile, the Dallas Fed conducted a survey of businesses to find out what they are doing in the face of tariffs. See the chart from MishTalk. More to the point, the Fed is worried about rising prices, and that’s who counts. So here we are back at the question of whether the Fed cuts rates and when, and whether it cuts before Trump figures out how to oust Powell and get the rate cuts he wants from a lackey.

Interactive means you can add/subtract from the component list. We added food, electricity and medical care. The one pointing upward is electricity. You could add back shelter, still at 4% y/y and the biggest component, but also falling. 

Honestly, there is still no sign of tariff-driven inflation. And as many have said, if it turns out to be a one-time shock instead of an on-going problem, the Fed can imagine a bump but an overall downward trendline that does allow for rate cuts.

Tidbit: Reuters has an explanation for the de-coupling of the dollar from stocks and bonds—hedging. Big funds in Canada and Europe are raising their dollar hedges. A Danish outfit is cited.

“The dollar's malaise has upended its traditional relationships with stocks and bonds. Its generally negative correlation with stocks has reversed, as has the usually positive correlation with bonds. The divergence with Treasuries has gained more attention, with the dollar diving as yields have risen. But as Deutsche Bank's George Saravelos notes, the correlation breakdown with stocks is ‘very unusual’.

“When Wall Street has fallen this year the dollar has fallen too, but at a much faster pace. And when Wall Street has risen the dollar has also bounced, but only slightly. This has led to the strongest positive correlation between the dollar and S&P 500 in years, though that's a bit deceptive, as the dollar is sharply down on the year while stocks are mildly stronger.

“Of course, what we could be seeing is simply a rebalancing. Saravelos estimates that global fixed income and equity managers' dollar exposure was at near record-high levels in the run-up to the recent trade war. This was a ‘cyclical’ phenomenon over the last couple of years rather than a deep-rooted structural one based on fundamentals, meaning it could be reversed relatively quickly.

But, regardless, the dollar's hedging headwind seems likely to persist. ‘Given the size of foreign holdings of both stocks and bonds, even a modest uptick in hedge ratios could prove a considerable FX flow,’ Morgan Stanley's FX strategy team wrote last month. ‘As long as uncertainty and volatility persist, we think that hedge ratios are likely to rise as investors ride out the storm.’"

Forecast

We are now in wait-and-see mode. The dollar is not seeing any follow-though buying so far today although we had some yesterday, especially in the yen, that is now treading water. There is some small possibility that a not-bad inflation report tomorrow, which is the consensus, allows for an earlier rate cut, not next week but how about end-July?  We would not like to hold any position in FX for long--the uncertainty is vast, aka 50-50. 

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